Finance Minister Bill Morneau has unveiled the finalized version of one of the controversial changes he first proposed last summer to the Income Tax Act.
Following a major backlash, then a series of consultations through the summer and fall, the minister has tweaked and clarified the plan.
Who is affected?
The measures coming into force on Jan. 1 will directly affect a small percentage of Canadians who have incorporated, establishing a Canadian-controlled private corporation (CCPC) for business purposes, and who use income sprinkling to reduce their tax burden.
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That means they are divvying up profits among members of their family, who may see that income taxed at a lower rate.
According to the Department of Finance, the number of businesses potentially affected is fewer than 45,000, less than 3 per cent of the total number of CCPCs in Canada.
The number of CCPCs has exploded in recent years, and the government believes that some business owners have been able to take unfair advantage of the existing rules surrounding the taxation of those corporations to save money.
The changes and clarity provided on Wednesday involve only the proposal linked to income sprinkling.
The original proposal was designed to crack down on business owners who were sprinkling income to family when those family members were not, in fact, contributing to the business. They should therefore see their income from the business taxed at the highest marginal tax rate — cancelling out any potential advantage.
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People who were sprinkling legitimately to family members working in their businesses would be left alone, the Liberals promised.
What wasn’t clear was how the Canada Revenue Agency would tell the difference.
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On Wednesday, Ottawa offered some clarification on that point. Morneau’s department outlined a series of “off-ramps.”
Basically, if a member of a business owner’s family falls under any of these categories, the CRA will automatically decide not to tax them at the highest rate — in other words, the way the family is currently being taxed won’t change.
- The family member is 18 or over, and has made a substantial labour contribution to the business. That means an average of at least 20 hours of work per week during the current year, or during any five previous years. Those five years don’t even have to be consecutive. If the business is seasonal (campgrounds or fishers, for example) the hourly requirement would only apply during the months when it’s up and running.
- The family member is 25 or older, and owns a percentage of the business that is equal or greater to 10 per cent. Family members who own part of a service-based or professional corporation (that carries on the professional practice of an accountant, dentist, lawyer, medical doctor, etc) would not qualify for this off-ramp.
- The family member is the business owner’s spouse, provided that the business owner him/herself meaningfully contributed to the business and is aged 65 or over. This off-ramp is being introduced “in recognition of the special challenges associated with planning for retirement,” the government says.
Ottawa says that people aged 25 or over who do not meet any of the exclusions above “would be subject to a reasonableness test to determine how much income, if any, would be subject to the highest marginal tax rate.”
In certain cases, officials added, adults aged 18 to 24 who have invested in a family business with their own money will also be able to use a reasonableness test on the related income and be taxed at a lower rate.
During Question Period, Conservative deputy leader Lisa Raitt said the changes announced Wednesday won’t help anyone.
“That is 45,000 small businesses in this country, who in the next two and a half weeks will have to understand these rule changes and then implement corporate structure changes to their own businesses in order to be able to be on the right side of the CRA,” Raitt said.
How will the CRA know?
According to officials, the CRA will not go into every business’ books. Instead, owners who sprinkle income will need to attest that they meet the qualifications to have the sprinkled income taxed at the lower rate, and the CRA will take them at their word.
As always, audits could be conducted and then it’s up to the business owner and family members to prove what they have said on their tax returns is true.
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The clarifications unveiled on Wednesday are among several adjustments the government has made to its overall tax-reform package following an onslaught of complaints from doctors, lawyers, accountants, tax experts, farmers, premiers and even some Liberal backbenchers.
In October, Morneau confirmed that he was adjusting proposals on passive income so only about three per cent of the “most wealthy” privately owned corporations will have to pay higher taxes. He also announced that the government would not move forward with measures that would limit access to the Lifetime Capital Gains Exemption, or with measures relating to the conversion of income into capital gains.
– With a file from The Canadian Press